S&P Global Ratings 1

Industry Top Trends 2020 Chemicals Slowing demand creates more challenges for credit quality

What’s changed? Weak chemical demand: Global demand for chemicals will remain weak in 2020 following a decline in demand in 2019. We anticipate a slowdown, or in some cases, a reversal of a recent trend of demand growth, but not a trough by any means.

Potential for excess supply: There are no indications yet that companies planning supply additions have responded to weaker demand in key subsectors, including petrochemicals and some fertilizers.

Trade uncertainty: Escalating trade disputes between the U.S. and China and the U.S. and Europe are among the variables adding to an environment of uncertainty,

What to look for in the sector in 2020? Revenue trends: Revenue could weaken for chemical companies exposed to end markets such as autos in which we anticipate greater global demand compression.

Product and raw material pricing: We expect product pricing, especially for commodity chemicals, to soften as a result of weaker demand. Some specialty chemicals may be able to hold their pricing.

EBITDA and cash flow: We generally expect EBITDA will remain flat or decline in 2020 after declining in 2019.

What are the key medium-term credit drivers? The duration and depth of the ongoing demand weakness: A determinant of credit quality will be how long demand remains weak. We expect some stabilization in 2020.

Cushions under credit ratings: Companies that have benefitted from helpful demand conditions in recent years with cushions in their credit metrics at their current ratings may have more stable credit quality and a smaller risk for ratings volatility.

Offsetting factors: The willingness and ability of companies to preserve cash flow and defer growth-related or other capital spending or investments, and shareholder rewards will partly influence credit quality.

November 20, 2019

Authors Paul Kurias New York +1 212 438 3486 paul.kurias@ spglobal.com

Paulina Grabowiec London +44 20 7176 7051 paulina.grabowiec@ spglobal.com Oliver Kroemker Frankfurt +49 69 3399 9160 oliver.kroemker@ spglobal.com Danny Krauss New York +1 212 438 2641 danny.krauss@ spglobal.com Danny Huang Hong Kong 852 2532 8078 danny.huang@spglobal.com Felipe Speranzini Sao Paulo +55 11 3039 9751 felipe.speranzini@spglobal.com Shawn Park Hong Kong +852 2532 8014 shawn.park@spglobal.com

Industry Top Trends 2020: Chemicals

S&P Global Ratings Nov. 20, 2019 2

Ratings trends and outlook Global Chemicals Chart 1 Chart 2

Ratings distribution Ratings distribution by region

Chart 3 Chart 4

Ratings outlooks Ratings outlooks by region

Chart 5 Chart 6

Ratings outlook net bias Ratings net outlook bias by region

Source: S&P Global Ratings. Ratings data measured at quarter end. Data for Q4 2019 is end October, 2019

Globally, the ratings outlook bias is slightly negative. The most dramatic shift appears to be in Asia, which had a large positive bias in 2018 but is now negative.

Overall, the proportion of stable outlooks has reduced over time in certain regions, such as the U.S. There have been more downgrades than upgrades in 2019 in Europe and the U.S., especially among speculative-grade credits. In Latin America, expected volume growth and operating efficiency gains contribute to our generally stable outlook in the region. In Asia, despite the challenges of weak prices, lower demand, and less favorable supply-demand fundamentals, the majority of outlooks are stable.

Industry Top Trends 2020: Chemicals

S&P Global Ratings Nov. 20, 2019 3

Chemicals Key assumptions

1. Chemical demand and pricing will remain weak

We anticipate subdued demand in 2020 following a drop in 2019. We also expect some pricing volatility in many commodities. The subdued demand coincides with ongoing global capacity additions in some chemical products. New capacity mainly in the U.S. and China will contribute to lower utilization rates in these chemicals, such as polyolefins. These challenging conditions could pressure credit quality, especially at high cost producers. However, most prices and demand will not reach a trough for most chemicals.

2. Financial policy will generally adapt to a more challenging environment

In a period of uncertain demand, with little to no earnings and cash flow growth and an increased potential for a recession, we believe many companies will be more judicious in using cash. More specifically, we do not expect companies to increase shareholder rewards or embark on meaningful new growth initiatives, and attempt to conserve cash if only temporarily until demand recovers.

3. Oil and natural gas prices will be low

In our base-case, we assume a WTI oil price of $55/barrel and a natural gas price of $2.5/gallon. This pricing maintains an oil to gas price ratio that favors gas-based producers of chemicals, mainly in the Americas and the Middle East, relative to oil-based producers in regions such as Asia. We believe prices for ethane, a key input for petrochemical production, and a constituent of natural gas, could be lower in 2020 on average, relative to 2019 pricing.

Key risks and opportunities

1. The demand downturn could be greater than we anticipate

An alternate scenario could play out, which we don’t factor in our base case. For example, our economist has raised the potential for U.S. recession to 30% to 35% from 25% to 30%. We also assume a 10% likelihood of a recession in Europe over the next 12 months. A recession in one or more regions is a key risk that could result in lower-than-anticipated demand and earnings.

2. Financial policy may not adapt

We could see little change in shareholder rewards, M&A, or elevated capital spending. This could hurt credit quality in an environment of weaker earnings and cash flows. A key credit risk is the inability or unwillingness of financial policy to respond to a changing environment with weaker earnings and credit metrics in 2020.

3. Some companies are more susceptible to demand and other shocks

Companies that we rate in lower categories including those rated ‘B’ and below, or companies with vulnerabilities (such as revenue concentrated in a few end markets) or those with high operating leverage could see sharp declines in earnings and cash flow disproportionate to the decline in sector demand.

Industry Top Trends 2020: Chemicals

S&P Global Ratings Nov. 20, 2019 4

The chemical industry has increasingly relied on debt to fund growth, acquisitions, and shareholder rewards in recent years. Years of low-cost debt, relative to historical averages, and generally healthy demand conditions have contributed to a nearly 100% increase in sector debt globally in the past decade. Generally improving EBITDA and cash flow have muted the impact of this debt increase on credit quality. That supportive demand environment changed 2019, and under the challenging conditions of the next 12 months, a key credit risk is the inability or unwillingness of financial policy to respond to a changed environment with weaker earnings and credit metrics in 2020.

Our ratings have anticipated supply overhangs in certain sectors and regions, most notably petrochemicals in the U.S. In China, we do not expect future petrochemical capacity growth will bridge the supply shortfall from domestic production. In sectors with large capacity additions and excess capacity, the absence of meaningful demand growth in 2020 will likely make the operating environment more challenging than we originally anticipated. Trade frictions add further credit risk. There are limited mitigating factors including potentially lower input costs. In commodity sectors with supply overhangs, we expect overall subsector earnings to decline, but producers with less-than-competitive cost structures will be especially hard hit. In the petrochemical sector, these would include naphta-based producers. There exists potential for increased petrochemical volumes (from capacity increases) at globally competitive producers to offset lower product pricing and boost EBITDA. However, any such improvements would be exceptions.

Not all commodity chemicals are experiencing a downturn. Our outlook is broadly stable on the prices of fertilizers. Still, there are downside risks relating mainly to the supply-demand balance in each fertilizer market and the behavior of producers in China. Overall, we think demand should be supported by the improved affordability of fertilizers, an important factor given challenging farm economics and pressure to sustainably increase food production amid persisting weak commodity prices, planting delays, growing resistance to herbicides, and the U.S.-China trade tensions.

We anticipate steady demand for nitrogen-based fertilizers in 2020, even though weather-related events could potentially disrupt the timing of the planting season in various regions. Lower natural gas prices will clearly continue supporting nitrogen producers' profitability, including those based in Europe, which remains at a structural cost disadvantage compared with North American peers.

The risks to prices for potash fertilizers in 2020 come from demand, rather than the supply side. In 2019, weak demand from China due to ongoing high potash inventories (estimated by market sources at about 3mt) led to potash producers like K+S, Uralkali, Mosaic, and Nutrien to take supply way from the market, either by reducing production or extending maintenance shutdowns. The supply from China, given the weak renmnibi and tight global urea balance, is also a key risk.

Finally, for phosphate fertilizer, the impact of additional supply from OCP S.A. and Saudi Arabian Mining Co. (Ma'aden) was partly softened by closures at The Mosaic Co.'s Plant City or Nutrien Ltd.'s Redwater facility. In China, while the increased environmental regulations put pressure on the local producers, the effect was mitigated by the devaluation of the Chinese renmnibi and lower demand in the domestic market. As a result, contrary to our previous expectations, phosphate exports from China – which accounts for about 35%-40% of the global phosphoric acid - increased in 2019 to date instead of declining. As we look into 2020, phosphate inventories in distribution channels are still significant, notably in the U.S. and India. We believe the pace of destocking, coupled with weather conditions and the timing of the planting season, will play a major role in the recovery of phosphate prices.

Industry Top Trends 2020: Chemicals

S&P Global Ratings Nov. 20, 2019 5

Related Research – BASF SE, Nov 13, 2019 – A Turning Point For U.S. Chemical Credit Quality, Oct 29, 2019. – Safety, Pollution Policies Push China's Chemical Industry To Upgrade, Oct 21, 2019 – Credit FAQ: What’s In The Mix For The Global Chemicals Sector?, Aug 19, 2019 – EMEA Chemical Companies, Strongest To Weakest, Aug 02, 2019 – Is Targeting U.S. Chemical Companies A Successful Formula For Activist Investors?,

Aug 01, 2019

This report does not constitute a rating action.

Industry Top Trends 2020: Chemicals

S&P Global Ratings Nov. 20, 2019 6

Industry forecasts Global Chemicals Chart 7 Chart 8

Revenue growth (local currency) EBITDA margin (adjusted)

Chart 9 Chart 10

Debt / EBITDA (median, adjusted) FFO / Debt (median, adjusted)

Source: S&P Global Ratings. Revenue growth shows local currency growth weighted by prior-year common-currency revenue-share. All other figures are converted into U.S. Dollars using historic exchange rates. Forecasts are converted at the last financial year-end spot rate. FFO--Funds from operations.

In our base-case scenario, we generally believe 2020 will be a year of stabilization for each region, but not a year of meaningful recovery after operating performance declined in 2018. However, we also believe there is now higher potential for an alternate scenario with near-recessionary conditions and a weaker-than-anticipated 2020. There might be exceptions in some regions and product categories, especially in certain specialty chemicals, in which producers may benefit from growth in certain niches and deflating raw material costs.

Industry Top Trends 2020: Chemicals

S&P Global Ratings Nov. 20, 2019 7

Cash, debt and returns Global Chemicals Chart 11 Chart 12

Cash flow and primary uses Return on capital employed

Chart 13 Chart 14

Fixed versus variable rate exposure Long term debt term structure

Chart 15 Chart 16

Cash and equivalents / Total assets Total debt / Total assets

Source: S&P Global Market Intelligence, S&P Global Ratings calculations

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P’s public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at Copyright © 2019 by Standard & Poor’s Financial Services LLC. All rights reserved. STANDARD & POOR'S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor's Financial Services LLC.

spglobal.com/ratings